Bank reserve ratio cut an encouraging sign

Hong Kong Trader, Feb 20, 2012 —

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China’s announcement of another cut in the bank reserve requirement ratio is a decisive move in the right direction. It also sends a strong signal that the country’s top policymakers have shed some, if not all, of their earlier hesitation to lean toward a greater loosening.

The People’s Bank of China (PBoC), the central bank, said on Saturday that it will cut the reserve requirement ratio, or the proportion of money that lenders must set aside as reserve, by 50 basis points, effective Feb. 24.

Before the announcement, the ratio for major lenders stood at 21 percent. The move is expected to add about 400 billion yuan (US$63.5 billion) to the market.

The latest action comes on top of a similar move that took effect in December, when the central bank slashed the ratio for the first time in three years. Earlier, the PBoC hiked the reserve requirement six times last year in a bid to soak up liquidity and tackle inflation.

Saturday’s announcement shows that policymakers have basically reached a consensus that economic growth, rather than inflation, is the biggest challenge facing China amid the lackluster global economic outlook.

Although the consumer price index growth accelerated in January, it is basically a result of seasonal factors. Inflation won’t be as big problem in 2012 as it was last year. Instead, economic growth has become the major concern, largely because of the deepening European debt crisis.

Earlier this month, the International Monetary Fund (IMF) said that an escalation of Europe’s debt crisis could slash China’s economic growth by half this year.

The IMF, in an economic outlook report on the world’s second-largest economy, highlighted China’s vulnerability to weak global demand.

“The global economy is at a precarious stage and downside risks have risen sharply,” the IMF said, citing the possible deep crunch in the financial sector in Europe that would be felt around the globe.

China’s growth could fall by around 4 percentage points this year from the 8.2 percent rate estimated earlier by the IMF, the report warned.

Asia’s largest economy has felt the pinch from the European pain, as the country’s exports to the EU and European direct investment in China both declined in January.

As the nation increasingly felt the pain of global economic slowdown, Chinese policymakers’ thinking has changed in the past few months. They first were reluctant to promise to offer a lending hand to the EU. But this month has seen China, at the highest levels, expressing support for Europe.

President Hu Jintao, Premier Wen Jiabao and Vice-President Xi Jinping, on different occasions, have said China is willing to consider greater involvement, especially through the European Stability Mechanism and the European Financial Stability Facility. Those were strong signs that top Chinese leaders were increasingly worried about the economic slowdown in China.

Indeed, China has plenty of room for a greater loosening in its monetary policies and it should not hesitate to do so as the economic situation has turned grim.

Yuan positions for foreign exchange purchases, an indicator of capital flow, fell for the first time in four years in October, and declined again in November and December.

As the trade surplus shrinks, foreign direct investment slows and yuan holdings moderate, there will be more space for further cuts and the reserve requirement could fall by between 2 and 3 percentage points over the year.

In addition, the broad measure of money supply, M2, which covers cash in circulation and deposits, grew by 12.4 percent year-on-year by the end of January, the lowest since June 2001.

The slower money supply growth was partly a result of the Lunar New Year holiday, when business activities ran to a low. But as the growth is the lowest in more than a decade, the figure shows up tight liquidity situation.

In fact, the reserve requirement ratio now stands at more than 20 percent, a level that has never been seen before. That is a strong indication that China’s earlier tightening policy was overdone.

As the external economic outlook remains grim, it is indeed the time for China to press ahead with greater loosening.

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